Leasing Out Letters of Credit – Understanding the Basics

With the number of buildings sitting vacant thanks to the recent economic downturn, landlords are looking to lease as much of their vacant space as possible. The most common type of security deposit is cash, but more and more landlords are turning to letters of credit as an alternative to cash or in addition to cash for high risk tenants or for businesses that are not on sure financial footing. Many landlords actually prefer letters of credit to cash because they are guaranteed by a third-party if the tenant defaults on their obligations. If this happens, the bank which has issued a letter will pay on behalf of the tenant.

Letters of credit used to secure leases are also advantageous for landlords because a cash security deposit will automatically become property of the debtor’s estate should they file for bankruptcy. Letters of credit, on the other hand, are not property of the tenant’s estate and are not subject to the same automatic stay that a cash deposit would be. This provides a level of protection for the landlord if the tenant finds himself in a situation where he must file for bankruptcy protection. Because this letter is an agreement between the debtor’s bank and the landlord, it is a third-party agreement which allows the landlord to recoup some of his lost investment.

Of course, letters are not perfect and do sometimes present a few problems. Enforcing a letter of credit can be a time-consuming procedure. It takes a landlord a greater amount of time to receive the money due to him from one of these letters than it does from a cash deposit. Generally, a landlord must present the letter of in person at a specific place in order to receive his money. When using a letter to secure a lease, it is critical that it be written very carefully so that it is not contingent on any circumstance that is under control of the issuing bank.

The conditions under which this letter can be enforced must be clearly stated and agreed upon by all parties in order for it to be enforceable. A bank will often use any situation to deny the request of the landlord for enforcement of the letter in question. Leasing these letters provide both tenants and landlords the opportunity to fill space that would otherwise sit vacant, but they must be approached with caution and common sense.

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